The real property tax familiar to residential property owners has undergone administrative changes recently as it relates to the taxation of oil and gas interests. In February, the Ohio Oil and Gas Association released a report showing that the oil and gas industry contributed more than $43 million in real property tax revenue in six counties between 2011 and 2015. The report also shows that $250 million additional tax dollars are expected over the next decade. The tax revenue has been a real boon to local school districts that rely on real property tax revenue for their funding needs.

Homeowners are accustomed to the real property tax measured by the combined value of their land and improvements, usually a house. The real property tax is an ad valorem tax, which is a Latin phrase meaning “according to value,” because it is one measured by value. Typically, the “true value” of the property is determined through a recent arm’s length sale or an appraisal taking into account sales of comparable property. By statute the taxable value is generally set at 35 percent of the true value and the millage rate, or tax rate, determines the amount of the real property tax bill.

Oil and gas interests in eastern Ohio, of course, have taken on added significance recently through the extraction of the Utica and Marcellus shale formations. With the increase in value of the land and mineral rights, tax administrators have run headfirst into issues with fairly and appropriately applying the real property tax. Depending on whether the oil and gas rights are leased or sold outright, the county auditor may or may not create a separate parcel, which has significant tax implications.

When oil and gas interests are leased

Where oil and gas interests are leased rather than sold, the auditor does not create a separate parcel for the oil and gas interests. The land and improvements are taxed as they regularly would be, but there is an additional real property tax on the oil and gas that is extracted. For tax purposes, the oil and gas is valued through an “income-producing approach” under a statutory formula. Ohio Rev. Code § 5713.051 directs that gas interests are valued through the following formula: the average daily production of gas (per barrel or MCF) multiplied by the Ohio Tax Commissioner’s assigned value per MCF (generally $5,310 per barrel – $220 per MCF at present). If a company purchases the oil and gas rights, but chooses not to produce and sell the oil or gas, then the taxable value of the interest is zero because there is no production or sale.

For purposes of administering the tax, the Tax Department obtains production information from the Ohio Department of Natural Resources, computes the tax under the statutory formula, and directs billing towards the producer of well. Each well’s API number provides an identifier that allows the Tax Department to avoid the administrative hassle of locating all taxpayers with an ownership interest in each well. Much like the severance tax, then, the real property tax is billed to the producer and measured by the volume of oil or gas extracted.

When oil and gas interests are sold outright

By contrast, in situations where the oil and gas interests are sold outright, the auditor creates a separate parcel pursuant to O.R.C. § 5713.06. The separate parcel may be valued as zero if the deed reflects only the transfer of oil and gas interests, pursuant to O.R.C. § 5713.051. But if the mineral rights transferred are more encompassing that oil and gas, to include other minerals, then the auditor may assign a value to the mineral rights under O.R.C. § 5713.06 and assess tax accordingly.

Tax controversy

This discrepancy has led to litigation in Belmont County. There, the difference between the value of oil and gas rights (zero) and broader mineral rights interests has caused Hess Ohio Developments LLC to file several appeals before the Ohio Board of Tax Appeals. Hess, which owns several severed mineral parcels, argues that its mineral interests are limited to oil and gas interests that should be valued as zero pursuant to the income producing valuation approach under O.R.C. § 5713.051. The auditor and school boards may argue, however, that Hess owns broader mineral rights interests that may be assigned a value and taxed accordingly.

Other tax controversies may also arise as the oil and gas industry in Ohio evolves. For example, a non-severed parcel of land holding oil and gas interests may appreciate in value due to market forces taking into account the value of the oil and gas interests. If the oil and gas interests were sold, however, the remaining parcel would presumably lose value without any corresponding value assigned to the severed oil and gas interests. If there is no extraction, the oil and gas rights could be assigned zero value for real property tax purposes under O.R.C. § 5713.051, in essence escaping taxation. Aggressive county auditors could presumably challenge this situation through assessments based upon the sale price of the oil and gas interests.

Despite the complications, the industry has been a boon to prosperity in rural Ohio areas and a catalyst for education that opens the door to upward mobility. As the oil and gas industry and tax administrators work through tax issues, they should mindful of progress with community development.